Make tax decisions that count

It's over. The red-flag April 15 tax-filing deadline has passed. But the truth is that throughout the year, you have to make decisions that affect your tax situation.

Michelle Singletary

It's over.

The red-flag April 15 tax-filing deadline has passed. But the truth is that throughout the year, you have to make decisions that affect your tax situation.

So it's not over. I hate to tell you, but it's already time to start considering what moves this year will have an impact on your tax return next year.

If you are thinking about making a purchase, it's smart to see if there are tax breaks associated with the buy. For example, here's a question I received during a recent online chat: "I'm considering installing a new furnace and heat pump to take advantage of the 2009 tax incentive. What are the tax implications?"

Before I answer that question, I need to first point out that you should never make a financial decision based solely on the tax implications. Certainly, how the move will affect your tax liability should be considered. But it shouldn't drive your decision.

As for installing qualified energy efficiency products in your principal residence, the American Recovery and Reinvestment Act of 2009 extended the tax credits available for such purchases. The credits for energy-efficient appliances and products were increased from 10 percent of cost to 30 percent, with a new maximum credit of $1,500. The credits are available for products installed Jan. 1, 2009, through Dec. 31, 2010.

So if you were planning to upgrade your furnace and heat pump, you might as well take advantage of the tax break which isn't slated to last for too long. I should add that a credit is much more valuable than a deduction. A tax credit reduces dollar for dollar the taxes you owe. A deduction only eliminates a percentage of the tax that is owed.

Here's another online question: "I am considering rolling my student loan into my mortgage refinance to take advantage of the lower interest rate. I plan on continuing to pay my student loan at the same rate (not stretching it out over 30 years). Are there any tax implications for this?

I assume not, since both are tax-deductible. And are there any other considerations?"

Let's look at the difference in the interest deduction for a mortgage versus a student loan.

Generally, the personal interest you pay is not deductible on your tax return. However, there is an exception for interest on student loans. For 2009, the student loan interest deduction up to $2,500 is eliminated if your modified adjusted gross income is $150,000 or more (if filing a joint return). For all other filing statuses, you can't take the deduction if your modified AGI is $75,000 or more.

That $2,500 deduction is a nice break. But the deduction for mortgage interest is probably the most coveted tax deduction available. Still, there are some limitations you need to keep in mind. You can only deduct the interest on the first $1 million ($500,000 if married filing separately) in home loans on a first and second home.

If you refinance, only the interest on the amount you borrow to pay off the old mortgage is deductible. The IRS classifies this as home acquisition debt. Any debt not used to buy, build or substantially improve a qualified home is not considered home acquisition debt. This debt qualifies as home equity debt. The interest deduction on home equity debt is limited to $100,000 ($50,000 if married filing separately).

Typically, student loans come with a hardship provision. Should you have difficulty paying your student loan because of a job loss or illness, you may qualify for a deferment or forbearance for up to three years. You won't get that kind of break with your mortgage.

A deferment is a temporary suspension of loan payments for specific situations such as re-enrollment in school, unemployment or economic hardship. You don't have to pay interest on the loan during deferment if you have a subsidized federal student loan or a federal Perkins Loan. With forbearance, your payments can be temporarily postponed or reduced. Unlike deferment, whether your loans are subsidized or unsubsidized, interest accrues. Various hardship payment options are also available for private student loans.

Too often I find people pile debt onto their mortgage because the interest is deductible. But long term, this may not be wisest financial decision.

Generally, I oppose rolling consumer debt onto your home loan. If the recession has taught us anything, it's that your mortgage should not be used as a dumping ground for other consumer debt.

And the best intentions can be thwarted. Sure, you may plan on making extra payments, but what if you can't because your financial situation changes. Then you've placed your home in jeopardy.

What these two questions show is that April 15 shouldn't end with you putting your tax files away until next year. Tax time is a good time to evaluate your total financial situation. Don't do just what's good tax-wise. Do what's best for your finances overall.

Contact Michelle Singletary, a personal finance columnist at The Washington Post, at singletarym@washpost.com.